By Ryan Fletcher Third Year, Runner Up Prize

Transcription

1 Do sports stars deserve their wages? Should their governing bodies introduce a wage cap? By Ryan Fletcher Third Year, Runner Up Prize Introduction The salaries of sports stars are often of public interest as it is widely believed they earn too much, especially when compared to more socially valuable professions such as teaching. Furthermore, it is argued sports stars high salaries can be a cause of rising ticket prices, much to the frustration of the fan. Moreover, the competitive balance of the sport is likely to lean in favour of the rich teams, which can potentially create large inequalities within leagues, lowering competitiveness and thus having a negative effect on the spectacle of the sport. From the perspective of the fans, a league with lower competitive balance can be perceived as less entertaining as the uncertainty of outcome dissipates predictability does not make for entertaining sport. Likewise, the players themselves may be discontent with inequalities within the league, and look to move elsewhere. The labour market in professional sports, as in any other labour market, conforms to basic elements of supply and demand (Rosen and Sanderson, 2001). This gives reason as to why sports stars can earn disproportionally high wages, which is what this essay will seek to explain. Furthermore, it will evaluate the impact of wage caps, with reference to both European and North American leagues. It is important to note these league systems are different in organisation: in North America, leagues are closed ; no promotion or relegation takes places, whereas in Europe, an open or pyramid league system is used, where teams can be relegated and promoted depending on their final standings in the league. Much of the literature in sports economics assumes that clubs are of profit-maximising nature. However, it has been argued, namely by Quirk and Fort (1997), that models assuming profit maximisation are inappropriate and instead they suggest there is evidence that English, Scottish and Australian football and cricket clubs (as well as some American sports teams) should be modelled as utility- or win-maximisers. This can have an impact on the effectiveness of wage caps. Win-maximising clubs may pay larger salaries in order to attract the best talent, resulting in high team utility; a salary cap may, therefore, interrupt their wage structure. Profit-maximising clubs, on the other hand, may have a more efficient wage structure. This is intuitive as they would be seeking to minimise costs to obtain the largest possible profit, and therefore, a wage cap may impact less significantly on them. Why Do Sports Stars Earn So Much? The elusive box office appeal, as described by Rosen (1981), is an essential factor behind the huge wages of sports stars. The ability to attract large audiences and to generate many transactions increases the revenue of the sports star (or, the seller ). The talent of the sports star is what these huge audiences are drawn in by, and this is what causes such disproportionate wages. Imperfect substitution exists between lesser talent and greater talent, even if there is greater compensation in terms of quantity, which is illustrated by Dobson and Goddard s (2001) example from football, explaining how if one assumed

2 Manchester United were three times more talented than Birmingham City, watching Birmingham City three times would not equal watching Manchester United once. Additionally, wages can rise dramatically with only small increases in talent and this is known as an economic rent, created by the scarcity and thus low supply of exceptional talent (Rosen, 1981; Rosen and Sanderson, 2001). Further, Adler (1985) explains how stardom can exist, which can create a hierarchy of income even without any hierarchy in talent. In essence, this suggests that although there can be negligible differences in talent among some sports stars, their respective income can be vastly different. Adler (1985) uses music as an example to suggest that consumption requires knowledge; music becomes popular (and therefore, highly consumed) by many people listening to and discussing it with one another. To gain greater knowledge of the popular music, fans must forego knowledge of other artists, limiting the amount of stars that can exist within the field. The same may apply in sports. Consumers may actually bid up the wage of a sports star as their knowledge of them increases their popularity, which intensifies the manager or owner s incentive to have them on their team and may limit the labour supply of stars. This is consistent with Rosen (1981) and Rosen and Sanderson (2001) explaining how sports stars can receive a following that goes beyond their contribution to the sport. David Beckham could perhaps be an example of this phenomenon of stardom. He became extremely well-known, both on- and off-the-pitch, and although it is hard to measure quantitatively, it is apparent that fans and managers or owners alike recognise his stardom. Figure 1 shows the interaction of supply and demand in the labour market for professional sports, which determines sports stars wage and can explain wage differentials. Indeed, it shows how these superstar wages can be determined. Due to scarcity of talent and the stardom effect, it could be argued that players with these qualities are a monopoly, that is, their talent is so unique it has no effective substitute. Therefore, their supply of labour is inelastic; Figure 1 shows the extreme case whereby labour supply is perfectly inelastic. Consequently, these players wages are demand driven and thus they receive what is referred to as economic rents; regular players would receive the new competitive wage after an increase in demand for labour, whereas the monopoly players would receive the new monopoly wage (Downward and Dawson, 2000). As labour demand increases, their wages increase significantly; as it is assumed the market for talent is competitive, mangers or owners are expected to pay players based on their marginal revenue productivity (MRP), that is, the amount in which their input of labour increases revenue (Fort, 2006). Real wage rate Monopoly labour supply New monopoly wage Competitive labour supply New competitive wage Initial wage

3 Stars are deemed to have a greater MRP than regular players, resulting in wage differentials within teams. Scully (1989) calculated that strong Major League Baseball sluggers add $3.9 million, whilst strong pitchers can add $7.1 million (both in 2004 US dollars). It should be noted that these figures were for strong players as opposed to superstars; it can be assumed that superstars can contribute even larger amounts to revenue. However, sports stars MRPs may well be misinterpreted by managers or owners, resulting in inefficiently high wages that are not profit maximising for the firm (Kesenne, 2000). The stars impact on team productivity may not be as large as expected. An example in football could be that a team sign a star player expecting that his marginal product will enable the team to qualify for the Champions League. According to Deloitte (2013), Manchester United received 36.4 million in 2012 for their Champions League participation for broadcasting rights revenue, and in 2011, when they reached the final, they received 53.2 million. Clearly, a vast amount of revenue is received through Champions League participation and so star players at these clubs can have a large MRP. However, if the team fails to qualify the stars MRP would be significantly lower. Consequently, they may be earning a lot more than their actual MRP, which is inefficient in terms of profit maximisation for the club. Moreover, the social value of professional sports is frequently called into question. At a time when Wayne Rooney can earn a reportedly 300,000 per week for Manchester United (Rose, 2014), a teacher for example, may earn only one tenth of this per year. Yet society values education (and therefore, the work provided by the teacher) much more than they value the entertainment provided by Wayne Rooney on the football pitch. So why can his earnings exceed a teacher s by this amount? The answer is what Rosen and Sanderson (2001) describe as personal scale of operations effect. Simply put, a teacher can teach only a certain number of students at any one time. Although the unit value per student is very high, a teacher s income is constrained by the limited number of students they can teach. Conversely, although the unit value per consumer of sport is much lower, the number of consumers they can reach is far superior to that of the teacher. The marginal cost per consumer for a football team is effectively zero, whereas a teacher s marginal cost to teach one more student can be relatively large. Dobson and Goddard (2001) liken this production technology to public goods, whereby the production costs depend only very slightly, or not at all, on the number of consumers. Unlike a true public good though, individuals can be excluded from consumption by not paying a television subscription fee or purchasing a

4 match ticket. Rosen (1981) describes this as a scale economy of joint consumption, and suggests that it allows for relatively few sellers to effectively supply the whole market. He goes on to say that combining joint consumption technology and imperfect substitution of talent, makes it obvious that talented sportsmen and women will receive high wages. Additionally, wages in Europe can be bid up as teams are thought of as win-maximisers, and thus want to keep or attract the best players. The Bosman ruling, as approved by the European Union in 1995 (Kesenne, 2003), allows free labour mobility in Europe; players are willing to move to a different team (and country) if they are offered higher wages. Whether or not sport stars deserve these extremely high wages can be a matter of opinion. An economist would argue that, due to the scarce supply and high demand of their talent, their high wage is perhaps justified. The limitless number of consumers could further condone disproportionally high wages and to add to this, professional careers in sport are often very short. However, it will continue to be argued that sports stars earn too much. The lack of social value to their profession, and the ever increasing wages will no doubt provide ammunition for condemnation of the level of their earnings, as well as the (lack of) financial stability of various European clubs. Lastly, if the star players underperform, their MRP may decrease. Their wages would most likely be correlated with this, resulting in an inefficiently, and undeservedly high wage. The Economics of Wage Caps Pressure to introduce wage caps in professional sports may become intensified as various clubs financial stability becomes worrying as well as the amount of negative media coverage surrounding many sports stars wages. The obvious effect of these wage caps would be a lower average wage for sports stars but how will this affect the sport? The competitive balance can be affected; the club s profits, as well as the wage distribution within teams. According to Kesenne (2003), a key difference between wage caps in the closed leagues of North America and the pyramid system in European leagues is that in North America, the objective of the wage cap is to guarantee profits for the owner, and to maintain competitive balance, whereas in the European leagues, the objective is to lower wage bills in order to preserve financial stability. Of course, competitive balance may be enhanced in European leagues too, whether it is the governing bodies prerogative or not. Introducing wage caps in European leagues would have a different impact to North American leagues, due to their difference in organisation. Foremost, the heterogeneity of teams in European leagues would make it impossible to impose a standard absolute wage cap across all teams. This is because a typical Belgian first division team will earn approximately 13% of revenue generated by a typical English Premier League club. Instead, it is suggested that a percentage-of-revenue wage cap is used. Due to significant differences in revenue for different clubs within the same league, competitive balance may remain relatively unchanged (Dietl et al., 2012). This reflects Kesenne s (2003) theory that European wage caps are primarily to improve a team s financial stability.

5 However, Dietl et al. (2012) go on to say that for governing bodies in sport to be able to introduce wage caps, they must prove that such wage caps will improve clubs financial stability whilst not negatively affecting social welfare. Their analysis shows that a percentage-of-revenue wage cap increases competitive balance and club profits at the expense of a lower level of aggregate talent (p317). However, in order for wage caps in European leagues to be justified, it must be strictly clear that social welfare will not be reduced. Unfortunately, this is ambiguous as a significant determinant of this is fan preferences. Dietl et al. (2009) explain how fans can have different valuations for the aggregate talent within the league and the league s competitive balance. The overall impact on social welfare is dependent upon these valuations. To analyse the effect of salary cap, Kesenne (2000) uses a two-club model; a big-city club and a small-town club. A key factor in each club s revenue is the size of the market in which they operate, which both clubs cannot control. Win percentage is the next most significant factor in generating revenue, as people like to watch winning teams (however, this has a decreasing marginal effect because if the club become too strong, it will be detrimental to the competitive balance of the league). Revenue is a function of market size and winning percentage. The composition of players in a team affects its win percentage and it is assumed that regular players marginal product is a fraction to star players. Total league revenue may decrease as a result of the more balanced allocation of talent because, using Kesenne s (2000) two-club model, and by using percentage-of-wage caps as suggested by Dietl et al. (2012), star players will have a greater marginal revenue productivity at a big-city club than at a small-town club. This is because a big-city club will have a larger fan base and thus more potential revenue (transactions). Therefore, losses from the big-city clubs are not offset by the increase in revenue from the small-town clubs and so total league revenue and social welfare is decreased. However, competitive balance in a league championship is imperative to its quality. The uncertainty of the outcome in matches between teams is what makes it exciting and can directly contribute to revenue (Kesenne, 2000). Indeed, the effect of wage caps can be positive for the competitive balance and thus enhances the outcome uncertainty. Therefore, it is difficult to determine what impact competitive balance will have on the league in terms of revenue and social welfare. Furthermore, a widely argued point for wage caps is that they lower wage bills, which lowers a team s total costs, and this leads to lower ticket prices. In fact, it is suggested that this is not the case and that wage caps have no effect on ticket prices. The reason for this is that in the US, teams are often local monopolists, and can therefore set their prices at a profit maximising level. As previously mentioned, a team s marginal cost is (close to) zero due to joint consumption the number of fans in the stadium and watching on television does not raise additional costs for the clubs and therefore, ticket prices are independent of player wage (Kesenne, 2000). It could be argued that in Europe, some cities can have multiple clubs within it, but even in these duopoly or oligopoly markets, similar monopolistic price setting can occur. Of course, the practicalities of introducing wage caps even percentage-of-revenue caps are called into question. If one governing body, the Football Association (FA), for example,

6 were in favour of caps and wanted to implement them, they would have to ensure that governing bodies across Europe (and potentially across the world), also implemented them. Otherwise, the best players could migrate to other leagues that do not impose a cap on earnings and potentially receive higher wages. This would negatively impact the aggregate talent of the league, quite possibly to an extent that even the increased competitive balance could not offset in terms of losses in social welfare and league revenue. Conclusion In conclusion, sports stars wages are determined by supply and demand, like in any other labour market. By combining the lack of effective substitution for exceptional talent with joint consumption the large scale audiences sports stars can sell to with a marginal cost of zero their wages are inevitably high (Rosen, 1981). Such a high demand, but scarce supply for the best talent will intuitively inflate wages (Downward and Dawson, 2000). In addition, the revenue in which stars can generate further argues the case for their wages, as long as their MRP is not misinterpreted. The effectiveness of wage caps in professional sports is unclear. An important reason behind them is to improve competitive balance, however, the only plausible way of implementing them is to use a percentage-of-revenue wage cap (Dietl et al., 2012), which would allow the big teams with higher revenue to pay players higher than the small teams. Thus, it could be argued competitive balance would remain relatively similar. Next, the issue of social welfare can provide impracticalities of introducing wage caps. It is argued that, due to higher followings for big clubs, by trying to lower their competitive advantage may drive down their fans welfare, which is not offset by the increased welfare of small club fans. The result: lower social welfare, and potentially lower league revenues. Of course, a positive for salary caps is the potential for greater financial stability, especially in European leagues, where many teams are thought of as win-maximisers who pay inefficiently high wages to improve team productivity. In essence, although some sports stars wages are tremendously high, it would be difficult to find an economist who disagrees with how their wages are determined. The main issue is a moral one. Their wages supersede those in a much more socially valuable profession, such as teaching. However, is the issue of morality enough to enforce wage caps? Due to the impracticalities and ineffectiveness of them as discussed in this paper, their implementation would be of little value, except perhaps an improved perception of the industry s morals.

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